An unprecedented global deal to slash oil supply and boost prices hung in the balance over Easter as Mexico resisted pressure from Saudi Arabia to cut output on the same scale as larger producers.
Latin America’s second-biggest economy refused to accept supply cuts of 400,000 barrels a day and has offered a reduction of 100,000 b/d instead. US President Donald Trump offered to make up the shortfall, but Riyadh held out for Mexico to toe the line. “It’s very important that we don’t provide an exemption like this because everybody will ask for one,” he said.
Leaders frantically tried to find a workaround over the weekend. Mexico is a relatively small participant in world oil markets and its own oil exports have been pummeled by falling prices. So why is it resisting?
President Andrés Manuel López Obrador thinks the cuts are unfair
The president is an energy nationalist born and raised in an oil-producing state during Mexico’s boom years and has made reversing 15 years of production declines at state oil company Pemex a policy holy grail. “It’s taken us a huge effort to increase production,” he said last week, adding that Mexico couldn’t be expected to cut on the same scale as a country that produced 12m b/d. Mexico’s production — which topped out at 3.5m b/d in 2004 — averaged just 1.693m last year and 1.786m b/d in March.
At current prices, many of Pemex’s fields are unprofitable. The company doubled its losses last year and has $105bn in debt. Accepting a 400,000 b/d production cut would have given the government an excuse not to have to pump more cash into Pemex at a time when state finances were under pressure — private economists see gross domestic product contracting as much as 10 per cent this year because of coronavirus.
But Mr López Obrador prides himself on his obstinacy and will not budge from his vision of Pemex as a lever of national development. He has already refused calls to defer construction of an $8bn refinery to redirect cash to the coronavirus crisis and maintains Mexico will refine an additional 400,000 b/d even though refineries are working at one-third capacity, so as not to “waste” oil by exporting at low prices. His goal — whatever the price — is energy self-sufficiency and he wants eventually to halt US fuel imports.
Mexico hopes to have its cake and eat it
Mexico is betting that the deal, with the backing of Opec and the G20 — is too important to founder as the world economy is ravaged by Covid-19. “The price is going up due to the deal. We’ll benefit from that and also from not cutting production that much,” one government insider said.
It is a gamble, though. “If you are able to be a free-rider, you win, but if it causes the deal to fall apart, you lose and everyone loses,” said Duncan Wood, head of the Mexico Institute at the Wilson Center.
Mexico has protection from oil price falls
In the first quarter of this year, the price of Mexico’s oil export mix tumbled more than 80 per cent amid Saudi Arabian-Russian battle for market share. It has since clawed back some losses — from a low-point of $10.37 at the end of March, it is now at $16.54. Mexico exports 1m b/d.
However, the government has bought protection from price falls via an annual hedge — one of the biggest and most secretive trades in oil markets — that guarantees it a price this year for the hedged volume of $49 a barrel. The operation typically costs about $1bn a year.
“It’s a put option. You collect independently of how much you produce,” noted one former senior Pemex official. Nevertheless, it gives the government a financial breather.
López Obrador calls the shots
The biggest reason for Mexico’s refusal to bend is that the president trusts his gut instinct and cares more about his domestic voter base than international relations. He also believes that, trading on a good relationship with Mr Trump forged last year when Mexico agreed to stem the tide of migrants heading to the US, he has resolved the problem.
“This is, simply, a one-man country,” says Carlos Ramírez, a consultant and former official.
